adminGift Mugano Business Correspondent
Export Processing Zones, Free Trade Zones and other forms of Special Economic Zones are demarcated geographical areas within a country’s national boundaries where the regulation of firms’ activity and the dedicated policies are differentiated from those applied to firms outside the zone.
The regulations are aimed at creating a policy environment and associated infrastructures that are exporter friendly, for both domestic and foreign producers.
Measures such as duty drawback, trade finance, subsidies broadly defined, domestic taxes and custom duties exemption, regulatory policies and public good provision, can be used in EPZs as well, but limited to a given geographic location. Interventions of this kind may be aimed at:
- Fostering production and employment in (potentially) exporting industries;
- Increasing foreign exchange profitability of (non-traditional) exporting producers, and
- Stimulating foreign direct investments in the given area when exporting by local producers is heavily constrained.
The reason for promoting EPZs is that it is a viable (second best) policy in the presence of strong economy-wide weaknesses and impediments to other national policies.
It is always recommended that the EPZ should not to be insulated from the rest of the economy and efforts be made to generate positive spillovers at an economy-wide level.
Key factors determining the success of EPZs are economic and political stability, profitability of local production (and related exchange rate policies), skill-content of local employment.
Of primary importance are also policies addressed to remove bottlenecks and weaknesses regarding availability of and access to infrastructures, regulatory constraints and services.
Again, in order to make EPZs work, interventions in the form of pure economic incentives, such as credit liabilities and preferential tax treatments, are of second order importance.
EPZs, providing benefits and exemptions to domestic and foreign firms locally producing, have proliferated in the last decade.
They became popular also due to the successful experience of the newly industrialised countries at the beginning of their development process.
Since the beginning of the 1990s, EPZs have been one of the most used strategies to increase exports in Latin American countries.
Almost all Latin American countries have indeed created EPZs with the only large country exception of Chile.
In Colombia, Special Customs Zones offer tax benefits to companies that set up operations in designated locations.
In El Salvador firms located in FTZs are given a 20-year income tax holiday and duty-free schemes for imported materials needed for production.
Countries in Central America seem to have benefited from EPZs, especially at the early stages of export growth in apparel, although the boom in some cases proved short lived (eg El Salvador), and results are still under fierce debate on whether authorities may issue industrial revenue bonds for manufacturing and commercial projects.
If the proceeds of the bonds are used to construct and equip a manufacturing facility, the interest on the bonds may be excluded from gross income for income tax purposes under certain conditions.
Previous research indicates partial success in some countries, but only limited to exports and employment outcomes.
Yet, very few cases passed a cost-benefit assessment.
Anecdotal evidence and some country studies confirm that results are generally disappointing: EPZs have generally been unable to generate the significant positive externalities they are theoretically predicted to yield.
There are however exceptions.
For instance, the EPZs created in China, Philippines, Honduras and the Dominican Republic has achieved successful results. Starting from the 1980s, the Chinese government extensively relied on EPZs and Open Coastal Cities.
The Open Door Policy was inaugurated in 1978 and consisted in favouring: (a) import of foreign capital, (b) import of advanced technology, (c) import of western management know-how, (d) export promotion and import substitution, (e) investment in human capital.
The locations of the first four SEZs were identified on the basis of their proximity to the regional world trading markets of Hong Kong, Macao were: Shenzhen, Zhuhai, Shantou and Xiamen.
The objective was to create a policy environment and associated infrastructures that were exporter friendly, for both domestic and foreign producers, in geographically isolated and controlled areas with favourable characteristics thanks to their location!
Firms locating in a SEZ were given preferential treatments in terms of taxation, import licensing and tariffs.
Furthermore, while in the rest of China investments were under control of the central planning, in the SEZs they could be made by autonomous decisions.
Over time, the scope of the SEZs has progressively been extended to cover more and more issues, also including: (a) free foreign exchange by foreign-owned enterprises, (b) insurance by foreign companies, (c) foreign trade restriction exceptions for approved enterprises, (d) port facilities for foreign enterprises, (e) new securities markets access for foreign firms, (f) reduction of tariffs and quotas, (g) infrastructure and reorganisation of bureaucratic systems, (h) exemption from state subsidies paid to employees, (i) tax exemption on profits remitted abroad, (j) duties drawbacks, and others.
The results of Chinese SEZs have been positive in terms of output growth, exports, employment and attraction of FDI, but they have not been evenly distributed among the geographic areas or among firms.
The firms that benefited the most are private firms located in coastal regions, which are closer to the most important regional world markets.
Moreover, not all sectors were supported: targeted sectors were only the textiles, machinery and electronic goods, which are those where China enjoys comparative advantage.
This strategy has been accompanied, starting from the 1990s, by a process of privatisation of state owned enterprises, and, starting from the WTO accession of China in 2001, by a progressive (but very problematic) process of trade liberalisation.
In Africa, a systematic assessment of the African experience on EPZs based on measures of their effects on a number of economic indicators: investments, exports, employment and structural economic change.
Results show that the African zones were unable to create a favourable climate for foreign investors and, in general (with the exception of Mauritius, Ghana and Lesotho), performed very poorly.
None of the African EPZs played an effective role in triggering the expected structural transformation in the export sector.
Mauritius is one of the few successful African cases. In this country the creation of EPZs stimulated the boom in sugar and export earnings in the 1970s, and caused an increase in the investment in joint-ventures between domestic and foreign investors in the special zones.
Of course important factors of attraction were tax holidays and duty-free imports.
However, the reason for the success of the Mauritius experience is in the way that the government of this country was able to create a favourable business environment, by fostering demand and supply of better educated workers, spurring innovation by domestic firms, improving information dissemination, and providing several supporting institutions.
Instead, in most of the other countries experiencing EPZs, attraction of foreign firms is primarily committed to advantageous tax treatments and consequently positive effects have not materialised at a national economy-wide level.
In these cases, it would be fair to say that subsidising foreign investors with the objective of increasing exports is a ‘silly policy’ because such a policy may result in transfers from poor country taxpayers to rich country shareholders.
In order, to realise the potential benefits of EPZ countries must follow the Chinese model illustrated above!
In this model, there is a total package such as excellent geographical location which offers proximity to international trade, tax exemptions, availability of infrastructure and total government commitment!
- Gift Mugano is an author and expert in International Economics and Development in Africa, PhD finalist (Economics) and a lecturer of International Trade and Finance at Nelson Mandela Metropolitan University. He is based in Port Elizabeth, South Africa. Email: [email protected], Mobile: +27 780 174 112.
Online Reporter